A new measure between sets of probability distributions with applications to erratic financial behavior

Nick James and Max Menzies

Papers from arXiv.org

Abstract: This paper introduces a new framework to quantify distance between finite sets with uncertainty present, where probability distributions determine the locations of individual elements. Combining this with a Bayesian change point detection algorithm, we produce a new measure of similarity between time series with respect to their structural breaks. First, we demonstrate the algorithm's effectiveness on a collection of piecewise autoregressive processes. Next, we apply this to financial data to study the erratic behavior profiles of 19 countries and 11 sectors over the past 20 years. Our measure provides quantitative evidence that there is greater collective similarity among sectors' erratic behavior profiles than those of countries, which we observe upon individual inspection of these time series. Our measure could be used as a new framework or complementary tool for investors seeking to make asset allocation decisions for financial portfolios.

Date: 2021-06, Revised 2021-12
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Published in J. Stat. Mech. (2021) 123404

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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2106.07377

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